NGL Energy Is Growing, But at What Risk?

NGL Energy (NYSE: NGL) has a lot of debt, making it a risky midstream energy master limited partnership, or MLP, play. The market cheered its recent investment in TransMontaigne (NYSE: TLP) , but the all-cash deal could increase NGL's debt even more. So was it a bad move? It turns out that the deal may slightly improve the company's cash flow, so the jury is still out.

The dealOn June 9, NGL announced an agreement with Morgan Stanley under which NGL will acquire the general partner, or GP, of TransMontaigne Partners L.P., another MLP in the same industry. The company will also purchase Morgan Stanley's approximately 19.7% of the outstanding MLP units. The $200 million purchase will provide NGL with all proceeds from the incentive distribution rights, or IDRs, held by TransMontaigne's GP along with the distributions from the MLP units. NGL's shares jumped 3.24% to $43.28 on news of the deal.

Chuck Dunlap, TransMontaigne's CEO, said that the deal would "complement NGL's diverse and growing business lineup." That lineup consists of four businesses involved in water solutions, crude oil logistics, NGL liquids, and retail propane.

The deal makes sense geographically, with TransMontaigne's assets in the southeast and Midwest rounding out NGL's assets in the west and northeast. NGL also has a good track record of integrating new acquisitions into its business, having acquired no less than 10 other companies in the period from its May, 2011 IPO to the end of 2012.

Challenges for NGLAcquisitions aren't the only source of NGL's growth. Its water solutions business is a small but rapidly growing part of the company. Oil and gas fracturing creates a lot of wastewater, and NGL has water processing facilities strategically located near the Permian, Niobrara, and Eagle Ford shale plays. It is growing this division organically by constructing new facilities in the Bakken and Marcellus shale regions as well.

But this growth story has a downside. Net earnings for the year ended March, 2014 barely budged from the previous year, even though sales more than doubled in the same period. The company's margins are razor-thin and shrinking, primarily due to the increasing interest rate expense. The company ended March with $10.4 million in cash equivalents, so the $200 million in cash for the TransMontaigne purchase can only come from more borrowing. Is TransMontaigne really worth this additional debt risk?

TransMontaigne is struggling tooTransMontaigne's assets, while a good geographical fit for NGL, haven't been faring well. It recently increased its distribution, but same quarter revenues, operating income, and net earnings were all down. Distributable cash flow was $16.6 million compared to $17.8 million for the same quarter last year.

Should Fools rush in?All this doesn't necessarily make the purchase a bad deal. In the first place, ownership by NGL can bring fresh industry expertise to the table, possibly turning TransMontaigne's performance around. Secondly, the deal may slightly improve NGL's cash flow.

NGL's revolving credit facility obscures its debt service picture, but current maturities and interest are about 4% of its long-term debt. At current performance levels, the $200 million TransMontaigne purchase should throw off $13 million in distributions from the MLP units and $1.7 million from the GP rights, giving NGL at least 7% on the investment. Borrowing $200 million at 4% to get 7% is fine, but it makes only a tiny dent in NGL's total debt service.

There's a lot of growth potential in this deal, but NGL's debt levels leave little margin for error. If you're comfortable with that, then now could be the time to act. If not, then you may want to see how the integration with TransMontaigne progresses, and for NGL's debt to come down to more manageable levels. If that doesn't happen, there are a lot of other fish in the sea.

Do you know this energy tax "loophole"?You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

Nice analysis. I think NGL got a lot of underperforming assets at an extremely fair price. About as big an apple as they can swallow at this point. Given what's happening in the industry these days they also make themselves an attractive acquisition target sans some parts in the future by the better heeled Lps. I think this will look like a smart lucrative deal in two years